Treasury Two-Year Yield at Highest Since 2010 Shows Bets on Fed

  • Yellen signals confidence in economy before Dec. 16 decision
  • Spread between two-, 30-year maturities narrowest since April

Treasury two-year note yields reached the highest level since 2010 as Federal Reserve Chair Janet Yellen said waiting too long to raise interest rates may hurt the economy, bolstering expectations that the central bank is poised to lift its target from near zero.

Government debt also dropped after private employment data suggested U.S. job growth is accelerating. The release led traders to reverse course after a report Tuesday showed manufacturing output shrank in November, spurring the biggest rally in 30-year bonds since September.

With Yellen laying the groundwork for a December Fed move and a gradual pace of tightening, the yield difference between two- and 30-year maturities shrank to the slimmest since April. Such a flattening of the yield curve signals traders are buying into the view that the Fed will keep inflation in check.

"It means that the Fed probably will begin its liftoff on Dec. 16 when the Fed meets and the market has to prepare itself for that," said Gary Pollack, who manages $12 billion as head of fixed-income trading at Deutsche Bank AG’s Private Wealth Management unit in New York. “The question will become, ‘When will the Fed raise rates for a second time?”’

2010 Levels

The benchmark two-year yield rose three basis points, or 0.03 percentage point, to 0.93 percent as of 5 p.m. in New York, and touched the highest since May 2010, according to Bloomberg Bond Trader data. The price on the 0.875 percent security due in November 2017 fell 1/16, or $0.63 per $1,000 face amount, to 99 28/32. The yield jumped the most since Nov. 6, when government figures showed employers added jobs at the fastest pace all year in October.

“On balance, economic and financial information received since our October meeting has been consistent with our expectations of continued improvement in the labor market,” Yellen told the Economic Club of Washington on Wednesday, according to a text of her remarks.

Futures indicate a 72 percent probability of a rate increase by year-end, according to data compiled by Bloomberg. The calculations are based on the assumption the effective fed funds rate will average 0.375 percent after liftoff, compared with the current range of zero to 0.25 percent, where it’s been since 2008.

‘Normalization’ Step

“She’s plainly making a case for the start of normalization of interest rates,” said Christopher Sullivan, who oversees $2.3 billion as the New York-based chief investment officer at United Nations Federal Credit Union.

Traders are taking Fed officials at their word regarding the pace of monetary tightening. The yield spread on 30-year notes over two-year securities fell to 1.97 percentage points, its lowest level since April 1 on a closing basis.

The 217,000 increase in November employment was the biggest in five months, according to figures released Wednesday by the ADP Research Institute in Roseland, New Jersey.

The figures signal that "we don’t have to worry about the Fed getting off track" and leaving interest rates unchanged this month, said John Briggs, head of strategy for the Americas at RBS Securities Inc. in Stamford, Connecticut.

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